Testimony of Dr. M. Bruce Johnson
Before the Joint Hearings of the

Senate Select Committee on Forest Resources
Senator Barry Keene, Chair

and the

Assembly Committee on Natural Resrouces
Assemblyman Byron Sher, Chair

Wednesday, October 28, 1987
St. Francis Hotel, San Francisco

My name is Martin Bruce Johnson. I am a Professor of Economics at the University of California, Santa Barbara. The California Forest Protective Association has asked me to study whether the Legislature should mandate sustained yield practices on private forest land in California and to present my findings to this Joint Committee.

I. What is the Problem?

One could infer from the title of these Hearings that some of you are concerned that recent corporate takeovers in California may pose a threat to California’s forests. In particular, you may fear that new managements may increase timber harvest rates above historical levels. These concerns lead to the questions being addressed today: will California forests be depleted or destroyed by more rapid cutting of timber? Does the state need a policy requiring private timber lands to be operated on some version of sustained yield in order to preserve their productivity?

Before addressing these questions directly, let me share with you my understanding of the best available current evidence concerning the causes and consequences of corporate takeovers in general. After discussing this in the economy at large, I will turn to the questions of whether corporate takeovers present special problems in the forest industry, and whether traditional methods of forestry management makes companies particularly vulnerable to takeover.

II. The Market for Corporate Control

Every business organization has the responsibility to manage its assets on behalf of the owners of the organization. The goal of the owners is to maximize the net worth of the enterprise, subject to legal and regulatory constraints involving, for example, employee and customer health and safety, or environmental externalities. Corporate managers perform this function as agents for stockholders who, increasingly, are pension funds and life insurance companies representing millions of ordinary citizens.

Changes in corporate control occur via takeovers (friendly or unfriendly) when a new managerial group believes that it can do a significantly better job of handling the corporation’s assets. The new group backs up its opinion by offering a premium for the corporation’s shares over the current market price of those shares. New management replaces old management. The evidence shows that takeovers and mergers improve efficiency, stimulate effective corporate management, and increase national wealth. Higher stock prices for the acquired firm’s shares clearly benefit those who ultimately hold equity in the firm through intermediaries such as pension funds and insurance companies. Takeovers are an important part of the competitive process we rely on to move resources to their most efficient uses.

Is the forest industry different? Some have suggested that new managements are interested only in short-term financial results and do not have a commitment to forestry as such. Stated another way, this new breed of timber industry managers is thought to have a fiscal orientation rather than the traditional production perspective of the forest products industry, and that this fiscal orientation has harmful consequences.

If the argument is that the new managers insist that forestry investments must compete with investments in other segments of the economy while traditional management acted as if they could ignore costs and prices, we should welcome the change. Because a great many consumer wants (both private and public) are not yet satisfied, we rely on prices and interest rates to guide the allocation of capital, labor and entrepreneurship into the most important and pressing uses. It is not in anyone’s interest to single out forestry or any other sector for special treatment, or to devote scarce resources to forestry that could be more productively employed elsewhere.

Aesthetic and environmental benefits are part of the payoff to good forest management, of course. But growing trees merely for the sake of growing trees without regard for the rate of return on the investment does not serve the public interest, because it means that other, more productive investment opportunities are foregone. Questions of how much timberland society wants to withdraw from production for aesthetic and environmental purposes should not be confused with questions of how well private commercial timberlands are managed.

III. Investment Horizons

Suppose it is alleged a private timber owner can’t be relied upon to take sufficient account of the interests of future generations and, therefore, must be regulated. The owner must be “guided” by the legislature in general and the State Board of Forestry in particular; he must be told when and how to plant, and when and how much to harvest. Is this charge of private shortsightedness well-founded?

When a private timber owner looks after his own interests, it does not follow that he will “cut and run” or in some other fashion maximize his short run gain with no thought for the future. If there is reason to believe the timber will be more valuable in the future, the owner will have every incentive to conserve and even augment his timber holdings in order to sell at a higher price later.

The factors that influence such decisions are many: they include estimates of future versus present prices of timber, lumber, and pulp; forecasts of discount rates, housing starts, mortgage rates, consumer preferences for wood and pulp products, and relative prices of substitutes; future technological changes in timber cultivation, timber harvest, and forest product manufacture; export opportunities, and import competition; and, finally, expected changes in the regulatory environment.

The many factors relevant to the private timber owner’s decisions affect his behavior in more ways than the obvious “harvest now or harvest later” choice. The timber owner makes many decisions regarding the type, extent, and timing of silviculture, reforesting inferior stands, control of brush, and expansion the areas under cultivation. Even though timber is grown on immobile land, timber owners still have considerable discretion in the level and intensity of forest investment and management. It is the net result of all these interrelated decisions that determines the nature of the private forests in California.

The inherent uncertainty of the future leads to several conclusions. First, each of the decision factors mentioned previously is subject to individual analysis, interpretation and, therefore,, differences of opinion. Given the same information, different timber owners will not necessarily reach the same conclusions with regard to investment prospects for the future; some will be good forecasters and some will not. Second, the uncertainty is of two varieties: economic and political. Most of the factors that must be anticipated in the course of managing timber assets fall into the economic category: prices, technologies, product innovations, and discount rates. The political uncertainties involve the future course of regulations and legislation. Although perhaps fewer in number, political uncertainties now swamp economic uncertainties as timber owners realize that politicizing private forest management in California may mean that private timber owners will lose their right to harvest. Indeed, this type of regulation threatens to take their property without compensation.

When timberland owners voluntarily delay the harvest of their timber, they make an investment. But they are becoming increasingly suspicious that they may be making investments that government will later declare unavailable for harvest. The owners are worried that they may be prevented from harvesting because their lands are near nontimber lands controlled by more numerous and more powerful political forces. The uncertainty that the timber owner’s rights will be sacrificed to the interests of other nontimber uses shortens the time horizon of timber owners and threatens to lead to premature harvesting. If timber ownership rights were secure and stable, timber owners would have the same long-term perspective as anyone viewing the future in a careful and rational manner.

The California State Board of Forestry, chaired by Professor Henry Vaux, acknowledged the danger of regulatory uncertainty in its 1981 publication: Renewable Resources Under Siege; the Board stated:

Managers of forestland face substantial uncertainties about the future which impede efforts to manage the land most effectively. These uncertainties include: . . . whether or not social pressures will permit some areas of timber growing land to be harvested in the future; . . . Policies to reduce these uncertainties are needed now, if the investment needed for the proper level of forest enhancement is to be made in time to yield the fullest return to society. (Underline in original, italics added)

If uncertainty over the right to harvest diminishes the timber owner’s ability to manage effectively and reduces his incentive to invest in forest resources, why is the author of the foregoing statement now supporting state control of harvests on private timberlands?

Taking the harvest decision away from the property owner is not a lasting solution. Once management decisions are placed in the political arena, long-term stability is ruled out. The political balance of forces is constantly shifting, especially in a democracy. Temporary majorities and alliances can even be formed for strategic reasons distinct from voters’ and representatives’ underlying interests. This is why the Founding Fathers set up constitutional protections of property rights, and why they established the separation of powers to further safeguard those rights. Perhaps this is why we have the Just Compensation Clause in the Constitution.

IV. The Decentralization Trend

It is ironic that at the same time some are proposing that private responsibility for economic decisions be replaced with state command and control methods, there is a growing worldwide movement in the opposite direction. Remarkable changes in attitudes about the economic organization of societies have been taking place in recent years. The trend, based on hard-won experience with the failures of politicized economic decision-making, is in the direction of deregulation and decentralization of control.

This deregulatory wind is clearly blowing in the democracies—the U.S., U.K., France, Japan, and the other industrialized free nations of the world. What is most surprising is that it is freshening the air in the socialist world as well. Poland is proposing to eliminate a number of government planning ministries in order to open up the stagnant Polish economy to market forces for the first time in 42 years. This is a repudiation of centralized management of enterprises and of the bureaucrats who resist innovation and change; it is also an admission that efficiency and productivity require market-based incentives.

The USSR, long plagued by low productivity, slow growth, poor product quality, and ubiquitous shortages, is now calling for a radical overhaul of centralized planning in favor of a much more market-oriented system.

The Peoples’ Republic of China launched its own unique program of economic reforms in 1978. The “individual responsibility” system under which parcels of agricultural land are contracted out to individual families or partnerships replaced a three-tiered system of communes, brigades, and production teams. Although the types of contracts vary, their common feature is that they recognize private, material incentives. The Chinese authorities have admitted, whether explicitly or not, that people are more productive when they are working for their own benefit than when asked to produce for the good of the state. Furthermore, the PRC has learned quickly; consider the account by Lynn Pan in The New Chinese Revolution (Hamish Hamilton, London, 1987, p. 24):

When first adopted, the contracts were meant to be temporary and indefinite in term. But no peasant was going to put much money into his land unless he could be sure it would be his for some time. So the term was set at three years; then at fifteen (or up to fifty years for horticulture), with even the provision that if the farmer should die before the term was up he could bequeath his contract to his descendants. Nearer and nearer, it seemed, the peasant’s rights to his land approached those of possession, or ownership of the means of production.

The point of these examples is that the harsh consequences of allocating resources by government edict has prompted even leaders who are ideologically committed to political control of the economy to face reality and admit that incentives matter. If no Chinese “peasant was going to put much money into his land unless he could be sure it would be his for some time,” can we expect a California timberland owner to be any less intelligent or sophisticated?

Legislation of a sustained yield policy on private lands in California will unambiguously reduce the private owner’s incentive to invest; his time horizon will be shortened because he will be less confident that he will be permitted to harvest when it is economically efficient or, perhaps, that he will ever be granted permission to harvest at all. In addition to shortening the time horizons of owner/managers, transfer of harvest decisions from the land owner to the state will raise the minimum acceptable rate of return for forestry investments, and will thereby reduce private investment. Indeed, the more the property rights of timber owners are threatened, the higher will be the risk premium they will require as a condition for investing. This increase in the internal rate of return required for forestry investments (including the decision to postpone harvest) will actually increase the chances of early cutting. Rather than protecting private forest lands from economically motivated premature harvest, mandated sustained yield legislation would have an effect opposite to that intended.

The effect of a mandated sustained yield policy in forestry would be as adverse on old or preexisting investments as it would on new investments. If timber owners lose their right to plan and execute their own harvests, they could and undoubtedly would contend that the harvest regulations diminish or eliminate the value of their property, thus interfering with their “reasonable investment backed expectations.” They will argue that they are the victims of a regulatory taking of their property.

In the last session of the U.S. Supreme Court, the majority opinion in First English Church held that temporary deprivations of use, if sufficiently severe to constitute takings, “are not different in kind from permanent takings, for which the Constitution clearly requires compensation.” In the Nollan decision, the Supreme Court ruled that “the right to build on one’s own property” was something more than a “‘governmental benefit.’’’ The First English Church and the Nollan decisions suggest a renewed concern that the burden of government regulations be fairly distributed. The central question as applied to the issue at hand is: even if a legislated sustained yield policy could be justified as serving a legitimate government purpose with public benefits, should the costs of that policy be distributed broadly or focused narrowly on the property owner?

When private citizens manage land and capital in a market economy with secure property rights, each owner assesses the risks of alternative choices and balances expected gains and losses. There is a clear incentive to anticipate what others will want and be willing to pay for. While the benefits of economically sound decisions are shared by producers and consumers, the costs of mistakes are concentrated on the private owners and entrepreneurs. They bear the consequences because their wealth will increase or decrease, depending on how well they anticipate future conditions.

When these decisions are politicized, correct anticipation of consumers’ wishes and consumers’ willingness to pay are replaced by strategic behavior—what will or will not work politically. Without a market to establish how much a resource is worth and how much of something else must be given up to obtain it, the political process looks to how many people want it and how well organized they are as an interest group. Rarely does the political outcome depend on any convincing evidence of the intensity of preferences, i.e., the willingness of consumers to pay for the benefits obtained. When politics decides the allocation of goods and investments, the link between benefits and costs is broken; the successful pressure group receives the benefits and everyone else bears the costs.

If we are genuinely concerned about the future productive capacity of forestry in California, if we are truly interested in encouraging additional private investment in existing timberlands, and if we honestly believe that additional private lands should be added to the existing forestry resource base, then the legislature should strengthen rather than weaken the incentive for private forest owners to invest and plan with long time horizons. Although the current legislature cannot pledge that future legislatures will respect the rights of private property owners, it can set an example for those to come. The current legislators should affirm their commitment to aesthetic and environmental concerns by recognizing the protection of these concerns provided by the California Forest Practices Act. At the same time, the Legislature should firmly reject any proposals that threaten to take harvest and other economic decisions out of the hands of private forest owners.